Essay on Accounting :- 1. Introduction to Accounting 2. Meaning of Accounting 3. Functions 4. Importance 5. Systems 6. Principles 7. Concepts 8. Accounting Conventions 9. Limitations.
- Essay on the Introduction to Accounting
- Essay on the Meaning of Accounting
- Essay on the Functions of Accounting
- Essay on the Importance of Accounting and its Users
- Essay on the Systems of Accounting
- Essay on the Principles of Accounting
- Essay on the Concepts of Accounting
- Essay on the Accounting Conventions
- Essay on the Limitations of Accounting
Essay # 1. Introduction to Accounting:
Several thousand years ago when human beings first developed the need to accumulate information about economic resources such as land, livestock and other personal property, accounting got originated. It emerged as an information system formulated for accountability in the exchange of goods and services.
With the invention of money there was an ease in the manner in which commodities and services were exchanged. Money became a unit of measurement. Throughout history accounting profession has continued to grow in response to the ‘financial information needs’ of individuals and societies.
Accounting is a function of economic and social development. It is the language of business. It records business transactions on a monetary basis in a set of books in a scientific manner. Cash plays a vital role in all types of business activities. One party pays it and the other party receives it. Even in non-cash transactions, cash has to be paid or received in future. Accounting provides information in a classified and a summarized form as financial statements.
It comprises Trading Account, Profit and Loss Account, and Balance Sheet. Account is that aspect of accountability that accounts for the purpose for which cash is paid or received. Trading Account and Profit and Loss Account are prepared to ascertain the profits earned or losses incurred for a particular period. The balance sheet shows the financial position of a business as at a particular point of time.
Accountants are the practitioners of accountancy. They are information specialists who collect, process and report economic information about specific financial events for business and non-business activities. Today, we observe several million individuals engaged in professional accounting activities and several billions dependent on such information. Thus, accounting has a wide scope in the spectrum of economic and social development of any country, be it developed, developing or backward.
Accounting 2. Meaning of Accounting:
Accounting is considered as ‘the language of business’. It is the language employed to communicate financial information of the business to various parties interested in such information. When an event is to be reported (say in English, Hindi, Kannada), certain rules are followed diligently so that what is communicated is understood by the readers appropriately.
Similarly, in accounting also the events of the business are to be communicated to the users by following certain set of rules diligently, so that the firm does not run into the risk of being misunderstood. Accounting language has two important components – (1) symbols in the form of ‘Debit and Credit’ and (2) grammatical rules in the form of generally accepted accounting principles (GAAP).
Accounting stems from ‘book-keeping’ the science and art of correctly recording in books of account all those business transactions that result in the transfer of money or money’s worth. Accounting relates to the work of maintaining various books of accounts, say, journal proper, subsidiary books, ledger, etc., which are generally done by junior employees as and when the transactions take place.
For this reason these books are called Books of Original Entry. Though the original records are maintained in a systematic way, they cannot by themselves provide information for judgement (decision) unless they are analysed and interpreted. Therefore, accounting comes into the picture.
Examining the cited definitions, we can infer that book-keeping is concerned with recording aspect. On the other hand, being comprehensive in nature, accounting includes book-keeping and spreads its tentacles to the analysis and interpretation of the data recorded. In fact, accounting designs proper system for recording the transactions.
The modern system of accounting is based on ‘double-entry principle’. Being scientific in character, double-entry principle of accounting has definite objectives to fulfill. It prescribes the process through which the objectives can be achieved. Accounting is a macro system.
In its micro system it includes several branches in the form of Financial Accounting, Cost and Management Accounting and others such as Government Accounting, HR Accounting, Inflation Accounting, Environmental Accounting, Farm Accounting, etc.
Accounting 3. Functions of Accounting:
Functions of accounting may be broadly classified into four categories:
1. Historical Function:
The primary function of accounting is historical in nature, i.e., to maintain a correct record. It includes recording, classifying, summarizing, analysing and interpreting the recorded data of an enterprise (an accounting unit). The major objective of this function is to report at regular intervals to owners/shareholders, management and other interested parties in a desired form and format through financial statements.
2. Managerial Function:
The major purpose of this function is to maximize operational efficiency. In this form it helps in planning future activities, controlling day-to-day operations by comparing actual results with predetermined standards. In short, accounting helps in decision making.
3. Legal Function:
From the viewpoint of accountability, accounting should satisfy the legal requirements of Accounting Standards Board (ASB) as well as the government. For example, audit is compulsory for ensuring compliance of standards.
4. Communicating Function:
Accounting, as a language of business, should be in a position to communicate the information to the users of information say, owners/shareholders, management, creditors, employees, consumers, investors, government, etc.
Accounting 4. Importance of Accounting and its Users:
The importance of accounting is unique as it is useful not only to the internal users but also to the external users (direct and indirect users). The importance of accounting can be understood in the popular use of this systematic information by the interested parties (i.e., the data processed in the form and format meaningful to the user). This systematic information is used by interested persons for decision making.
However, there is no unanimity in different countries as to who these interested parties are. For example, Accounting Standards Board (ASB) of USA in its Statement of Financial Accounting Concepts (SFAC) No.1 states that ‘Present and potential investors, creditors and others are the users’. The Corporate Report (1975) London lists all types of users who need accounting information. The Stamp Report (1980) Canada states that because of broader accountability concept in Canada, the range of users is also broader.
However, the International Accounting Standards Committee (IASC) lists investors, employees, lenders, suppliers and other trade creditors, customers, government and their agencies, public and management as users in its framework (1989). Taking into consideration the above list of users, categorization is made as users of information having direct interest and users of information having indirect interest.
1. Users having Direct Interest:
The users having direct interest in accounting information are considered to be owners and potential owners/management, shareholders and potential shareholders, creditors and potential creditors, suppliers and potential suppliers, employees and consumers, government and tax authorities.
They are briefly discussed in the following list:
(a) The owners/shareholders provide funds to an enterprise in the form of capital. Hence, they are interested in accounting information to know whether the business is conducted on sound lines, whether the capital is used properly, whether it is in a position to provide best of the returns on their investment and whether the business is run on legal and ethical norms.
The income statement and the statement of affairs prepared from time to time should be in accordance with the accounting standards so that comparability and decision making become easier.
(b) The management is interested in financial accounting to determine whether the business is profitable, whether the position is sound and whether it has competitive advantage. Financial accounting, being the eyes and ears of management, facilitates decision making in relation to expansion, diversification, etc., and framing of suitable policies for future.
(c) The creditors are interested in the financial soundness of a business. They may be suppliers of goods on credit, lenders of money, bankers and others who would support the enterprise by providing credit facilities. Their main interest is security for credit, apart from income. They carefully scrutinize the income statement and position statement from time to time in addition to watching the business operations closely from outside by means of disciplined enquiry.
(d) The investors/prospective investors (apart from shareholders) are interested to know how far their investment is safe or is going to be safe. They examine carefully the statements of income and position to assess the soundness of the business. Altogether they are interested in the safety of their investment along with returns.
(e) The consumers are interested to get the goods at a fair price (comparatively reduced price). They are much interested to know the control mechanism adopted by the enterprise so that cost reduction is made possible.
(f) The employees are interested in accounting of the enterprise so as to assess the profitability which would be the basic factor for determining higher wages, bonus, better working conditions, etc. The sound financial position of the enterprise encourages them to contribute their best to the firm.
(g) The government (central, state and local bodies) is interested in accounting of the enterprise to know the earnings based on which taxes could be collected to formulate revenue. Further, for compiling ‘national income’ accounting prepared on the basis of accountability becomes essential.
(i) The general public is interested in the accounting of a firm from the point of view of the firm’s social responsibility. In addition, it may comprise prospective lenders, investors, consumers who would closely watch the financial progress of the enterprise.
(j) The researchers are equally interested in accounting of an enterprise. They utilize the data for their research purposes to interprete and suggest new ways of maintaining accounts based on standard measurement, usefulness and decision making.
Thus, the importance of accounting is recognized by its users and with the fact that accountability cannot be established without accounting.
2. Users having Indirect Interest:
The users having indirect interest in accounting information are considered to be financial analysts, stock exchanges, lawyers, regulatory authorities, registration authorities, financial press and reporting agencies, trade associations and labour unions. These users are generally agencies which help/protect such persons or potential persons having a direct interest in them.
Table 6.1 provides decision usefulness of accounting information.
Accounting 5. Systems of Accounting:
Business transactions are normally recorded under ‘two different systems’.
They are as follows:
1. Cash System of Accounting:
Business transactions relating to actual cash received and actual cash paid are recorded under this system. Business transactions relating to outstanding are not recorded, i.e., if any amount is ‘due to’ or ‘due form’ some body it is not recorded. Government accounting is done under cash system. Generally, professional people like lawyers, chartered accountants, medical practitioners also follow this system. This system is not advocated for business enterprises as it poses difficulty in ascertainment of profit or loss.
2. Mercantile System of Accounting:
This system is advocated for business enterprises, as this system permits the recording of both ‘cash and credit’ transactions in the books of accounts. This system facilitates ascertainment of profit or loss of the business relating to the current accounting period appropriately.
In accordance with the accounting concepts, it is necessary to follow double-entry system (dual aspect concept). However, we observe, a few sole traders maintaining their accounts under single-entry system (where only cash and personal accounts are recorded) which is unscientific and incomplete.
Such types of accounts should be converted into double-entry system, if they are to be accepted by the concerned authorities or users. Therefore, single-entry system of accounting is not advocated either under cash system or under mercantile system.
Accounting 6. Principles of Accounting:
Accounting principles are the ‘norms’, ‘rules of action’ or ‘a body of doctrine’ to be followed while recording business transactions (data), converting data into information (financial statements) and communicating the same to the users (form and the format). These principles serve as guidelines to ensure uniformity, clarity and understanding.
The scientifically laid down principles should satisfy the criteria of relevance or usefulness, objectivity or reliability (not influenced by personal judgement), and feasibility (i.e., implemented without undue complexity or cost). Further, such principles based on ‘accounting concepts’, ‘accounting conventions’ formulating into ‘accounting standards’ should enhance the effectiveness of accounting.
These scientifically drawn principles are though labelled as concepts, conventions, precepts, cannons, norms, methods, postulates, doctrines, tenets, assumptions, axioms, standards, principles, etc., by professional thinkers are broadly categorized as concepts and conventions and grouped under GAAP.
Generally Accepted Accounting Principles:
Generally accepted accounting principles (GAAP) consist of the norms laid down in the form of principles, concepts and conventions to be strictly followed by the accountants to provide quality information to the users.
Indian GAAP comprises a set of pronouncements issued by various regulatory authorities, but predominantly controlled by the Institute of Chartered Accountants of India (ICAI). Indian Companies Act, the SEBI, the Reserve Bank of India, the Income Tax Act, the court pronouncements, etc., are the other regulatory bodies which contribute to Indian GAAP.
Accounting concepts are the principles followed by a business concern regarding the recording, classifying, summarizing of transactions and the analysis and evaluation of results.
Some of the accounting principles explained are as follows:
1. Historical cost concept
2. Money measurement concept
3. Going concern concept
4. Matching concept
Financial accounting is basically concerned with the historical events of an enterprise. The data relating to completed business transactions represent the focus on accounting. Under historical cost concept, values are recorded at the time the transaction was completed instead of current or future values (value measurement concept). This is because the use of historical cost provides an objective measurement for processing accounting data. For example, a piece of land was purchased in 1990 for Rs.10,00,000.
The same value is reflected in the books of accounts while recording this asset in the year 2010 (current year), despite the huge escalation in the real estate values (conservative principle). In the case of depreciable assets, historical cost minus depreciation is the value at which the asset is shown in the current year. Historical cost method of recording the transaction enhances the objectivity of reporting the business events for decision making.
Transaction descriptions may be recorded on qualitative or quantitative terms. If the description is based on qualitative terms, which relies heavily on judgement and interpretation, accounting fails to provide realistic information. For example, an entrepreneur records in his books that he has paid a ‘lot of money’ for the new car purchased.
Here, the description is in qualitative terms – the phrase ‘lot of money’ can be interpreted differently by different individuals. For a sole proprietor Rs.1,00,000 may be a lot of money but for a corporate enterprise this same amount may be insignificant. When the business enterprise records this transaction with a description of ‘paid Rs.1,00,000 for the new car purchased’, it is recorded in quantitative terms.
This description conveys the same meaning for both the sole proprietor and the corporate enterprise. To have clarity of common understanding, financial accounting requires quantitative description for recording the transactions as it satisfies the money measurement concept. This measure identifies money as a common denominator and the basis for quantifying transactions. As financial accounting deals with financial data, recording transactions in monetary terms becomes very essential.
The going concern concept necessitates the accountant to record transactions at historical cost, as it directs the accountant to treat the business enterprise to continue to exist indefinitely. However, the information users require are periodic reports (generally one year from April 1 to March 31) to make informed decisions. The concept of periodicity supports the preparation of periodic accounting reports.
Periodic reporting requires the transactions recorded during that period (input) be processed and used for the preparation of financial statements (output). This output provides a quality information in quantitative term to the users.
Matching concept is used while preparing the financial statements. For example in the income statement, revenues are matched with expenses (resulting in excess of revenue over expense or vice versa). In the position statement, assets are matched with liabilities and owner’s equity to show the balancing effect.
Accounting 7. Concepts of Accounting:
Concepts are thoughts, understandings, assumptions, basic conditions or notions based on which accounting system is developed. In a social science, a system cannot be developed unless certain assumptions or basic conditions are satisfied, so much so, with accounting.
Some of the important accounting concepts are as follows:
1. Business Entity Concept:
This concept distinguishes ‘business unit’ from its ‘proprietors’ or ‘owners’. As per this concept, business unit is treated as a separate entity distinct from its owners. The owners are considered as lenders and the capital invested is treated as liability of the business. For example, Mr. ‘A’ (the proprietor) invests Rs.60,000 into his business enterprise, ‘BE’ as capital. Then Rs.60,000 will be treated as the amount owed by ‘BE’ to Mr. ‘A’.
Suppose, during the course of conducting the business, he withdraws Rs.10,000 to pay the college fee of his son, then, in the books of ‘BE’ the amount owed or the capital (liability) will be reduced to Rs.50,000 (60,000 – 10,000). The facilitating factor here is that the business transactions are unique to the business and are not to be mixed up with proprietor’s personal transactions. Thus, business entity concept is established.
This concept holds good for all forms of business organizations, say, sole proprietorship, partnership or company organization. By following this concept an artificial/legal person is recognized distinguishing the same from individual or individuals (natural person). Here, every transaction is recorded ‘from the business unit’s viewpoint’ and the personal transactions are separated from business transactions. This concept creates a basic foundation for business entity.
2. Going Concern Concept:
Here, the major assumption is that the business unit has a long life (infinite period). Unless it is a short venture, business units hope to continue for a long time and prosper. Hence, while valuing business assets, the cost of the assets is recorded in the business by deducting depreciation considering the date of purchase.
In the sense, asset cost minus depreciation up to date is the value at which the asset is shown in the business. Based on this concept, distinction is made between capital expenditure and revenue expense.
The cost of the asset is treated as capital expenditure and the annual depreciation is treated as revenue expense.
3. Cost Concept:
Cost concept and going concern concept are complementary to each other. There are two values which can be attributed to purchase of any asset, i.e., cost price and market price. It is generally accepted that the assets should be recorded in the books at the cost price to form a base for subsequent operations. The market price becomes immaterial for the business unit as the business is not going to be liquidated soon, but is going to continue for long. The major advantage of the cost concept is that ‘it prevents arbitrary values being recorded in the books’.
4. Money Measurement Concept:
According to this concept, transactions which can be measured in terms of money only are recorded in the books. The transactions which cannot be measured in terms of money are either omitted or noted separately in a note book or a dairy only to provide additional information.
5. Accounting Period Concept:
As the life of the business unit is assumed to be infinite, we have to wait to know the result of the business (profit or loss) till an infinite period or liquidation. Waiting for such a long period is ridiculous. Therefore, accounting period concept is introduced by splitting the longevity of the business into a shorter and convenient period, say, 12 months duration based on the convenience of the business unit. However, to facilitate uniformity in assessment, the tax laws suggest the accounting period to be between April 1 and March 31 (12 months).
6. Realization Concept:
This concept relates to revenue recognition. The ‘actual revenue earned’ during the accounting period is recorded in the books, irrespective of whether cash is received or not. This means revenue is stated to have been realized on the date on which goods and services are transferred. For example, a business unit sells goods for X 15,000 on February 1, 2009 and receives cash Rs.5,000 immediately and Rs.10,000 on May 1, 2009.
In accordance with the realization concept, the sale value of Rs.15,000 should be recorded in the books for the year 2008-2009, though Rs.10,000 is received in the next financial year, i.e., 2009-2010. This method of recording facilitates the calculation of the actual income earned during the current period. Therefore, realization concept and accounting period concept are complementary to each other.
7. Accrual Concept:
This concept reinforces the realization concept as it takes into account not only the recognition of revenue but also the expense. It recognizes the total revenue to be received and the total expense to be paid irrespective of whether cash is received or paid. To facilitate correct ascertainment of profit or loss during the current period, the total income earned and the total expense incurred during the current period are taken into account regardless of the fact whether incomes are received or expenses are paid.
The very fact that the revenues earned or the expenses incurred form the base for accounting taking into account the current period in question justifies the accrual concept.
8. Matching Concept:
Matching concept seeks to establish a casual relationship between revenue and expense as they are the basic factors considered for ascertaining the profit or loss of the business unit. The main text of this concept is that the revenue earned during the current period and the expense incurred during the same period should be considered (matched) to ascertain the result of the business unit. Thus, matching concept confirms that there is a need to link the realization concept, accrual concept and accounting period concept.
9. Dual Aspect Concept/Accounting Equivalence Concept:
This concept is the outcome of entity concept where the business unit is considered as an independent entity as distinguished from owners/shareholders. This treatment enables us to understand that each transaction of a business unit has two aspects – (a) receiving of the benefit aspect (debit); (b) giving of the benefit aspect (credit).
For example, X commences business introducing his personal cash of Rs.80,000 as capital of his business unit. The business unit being an independent entity requires recording of this event in its books, taking into account the receiving aspect and the giving aspect.
Here, the business unit receives cash of Rs.80,000 (an asset in the form of cash – receiving aspect) and this cash received forms the capital of the business which should be returned to Mr. X (capital being a liability – giving aspect). This indicates every receiving item has an equal giving item or items, or vice versa.
This is recorded in the form of accounting equation, which is as follows:
The dual aspect concept forms the basis for double, entry principle to be followed in accounting to affirm that every debit has a corresponding credit formulating to an accounting equation, Assets = Liabilities.
Accounting conventions are ‘general rules of practice’ formulated out of customs, usages and traditions as guiding principles for accounting. The accountants follow these rules on a conviction that the accounting practices should be consistent, the financial statements should be prepared on a conservative basis to mitigate the risk of loss and the vital information relating to accounting should be disclosed.
1. Convention of Consistency:
This convention affirms that a business unit should be consistent in its accounting practices, so that the users of information are able to make comparison of accounting statements over a period or between different business enterprises. This consistency should be of the nature of general acceptability. That means, accounting practices should remain unchanged unless the change is necessarily warranted.
However, consistency does not prevent the introduction of innovative methods of accounting. But it is essential that such a change is incorporated and its effect clearly stated, so that the decision makers are not misled. For example, there is a change in the depreciation policy, i.e., from straight line method to diminishing balance method. This aspect should be clearly disclosed along with financial statements.
2. Convention of Conservatism:
Generally, financial statements are drawn on the convention of conservatism following the maxim ‘anticipate no profit but provide for all possible losses’. This practice prevents accountants to prepare the financial statements with ‘prejudice using personal judgement’. Window dressing is not permitted according to this convention.
For example, the general practice followed to value stock is, ‘cost or market price whichever is lower’. Suppose, the accountant has been valuing the stock consistently at cost price only without taking the lower market price into consideration, then the accountant has not followed the principle of conservatism, which is completely against this convention.
Thus, conservatism convention insists that all types of anticipated losses should be provided for before ascertaining the profits of the enterprise.
3. Convention of Material Disclosure:
Material disclosure means, ‘the disclosure of vital information’ relating to the preparation of financial statements. What is material or significant information depends on the circumstances and discretion of the accountant. Discretion does not mean personal judgement but judgement based on facts. This does not also mean that every minute detail should be provided.
It means the accountant should use his/her discretion only to distinguish between significant and insignificant information and disclose all significant information in the form of footnotes, references, using parentheses, etc., so that the financial statements are understood properly by users. For example, in addition to the asset values, the mode of valuation should also be stated. If there is any change in the accounting policy between the previous years and the current year, it should be stated in the footnote.
Thus, GAAP acts as the basic tenets to be followed in accounting to provide quality and user friendly information.
Accounting 9. Limitations of Accounting:
However, accounting has certain limitations.
Some of the limitations are as follows:
1. Accounting is an inexact science.
2. Accounting does not consider transactions of non-monetary nature.
3. Changes in value of money are generally not considered while determining cost and price.
4. The prevailing broad-based alternatives may cause confusion when information is used for comparison. Example inventory cost may be ascertained by LIFO or FIFO; stock may be valued at cost or market price; depreciation may be provided under fixed instalment method or reducing balance method.
5. As the policies framed are normally subjected to accountant’s judgement, they may be subjective.
Despite these limitations, accounting has a wide scope because of its standard measurement and GAAP. In fact, accounting as a discipline lends itself to the application of scientific method while converting accounting data into information. Pertinent data are collected, significant relationships in respect of the data are established, and generalizations are deduced and put to test on experience on the basis of accepted norms.
Accounting has the character of users’ acceptability for decision making. By its very nature, accounting is a behavioural process. This is because it influences the behaviour of its users. Hence, it is an integrated part of behavioural sciences. Based on the growth process of business and the requirements of its users, there is always the scope for research and development in accounting.